Five Dangerous Developments

It’s a long holiday weekend (and today also happens to be my birthday). I’m celebrating with family and friends, and I’m sure you are, too. So I don’t want to take up too much of your time.

But I also don’t want to ignore some potentially huge events in the markets. So here are five dangerous developments that are definitely worth contemplating in between your bites of leftover turkey sandwiches … turkey soup … or turkey casserole.

First, the dollar is on the ropes … it’s in really, really big trouble. Take a look at the U.S. Dollar Index (DXY). The DXY is the broadest measure of the dollar’s strength or weakness because it tracks the greenback’s performance against six major world currencies, including the euro and the Japanese yen.

You can see in my chart that the DXY is breaking through an uptrend line that dates all the way back to the December 2004 low. This could signal a new, major leg down — one that should drive up the price of everything from gold to funds holding foreign bonds.

And a weaker dollar is especially good for international Exchange Traded Funds and American Depository Receipts (ADRs are U.S.-traded versions of foreign stocks). Heck, one ETF we’ve been recommending in ETF Power Trader is up more than $10 a share in just the past few weeks! Second, private equity firm Blackstone Group just announced that it will buy Equity Office Properties (EOP). EOP is a major Real Estate Investment Trust (REIT) — it owns and operates 580 office buildings all over the country. The agreed upon price was $36 billion, including debt. Not only is this the biggest real estate deal ever, it’s the biggest leveraged buyout (LBO) of any kind … ever.

What’s going on? Like I said last week, there’s “Money, Money Everywhere.” According to Bloomberg, LBO firms have spent $600 billion in takeovers so far this year. That’s two and a half times the $241 billion in deals last year.

The problem is that firms are buying because they have money burning holes in their pockets, not because the fundamentals are dramatically improving.

Don’t just take my word for it. Investment Dealers’ Digest recently gathered some of the top thinkers in the commercial real estate sector together for a forum. Their comments were revealing. I especially loved this paragraph summarizing the sentiments of Benjamin Harris, head of domestic investments at the REIT firm W.P. Carey:

“Harris seemed to throw up his hands and, ultimately, reluctantly declared himself willing to go along for the ride. He believes the run-up in real estate valuations is capital-markets driven — in other words, powered more by investors needing to do something with their money than by improving prices per square foot, declining vacancies, and so forth [emphasis mine].”

This is the same thing we saw with tech stocks and residential real estate. Now, it’s commercial properties. Will we ever get a break from this constant stream of easy money-fueled bubbles? I sure hope so.

Third, did you get a load of those housing starts and building permit numbers for October? Starts plunged 14.6% to a seasonally-adjusted annual rate of 1.49 million units. That was a six-year low. Building permit issuance (for future construction) also tanked to its lowest level since December 1997.

This gives us yet another reason not to buy into that “soft landing” crap the real estate industry keeps talking about.

Fourth, shorter-term bills are yielding more than bonds with longer maturities. In fact, the difference is wider than at almost any time in the past two decades.

In short, this means the bond market thinks there’s almost a 40% chance of a recession in the next year. It also means there’s very little incentive for anyone to buy bonds with longer maturities right now.[Editor’s noteIf you want to learn more about the significance of this indicator, read “The Big Bond Squeeze.”]

Fifth, despite all these other developments, stock investors don’t seem afraid of anything.

One thing I’m watching is the CBOE OEX Volatility Index (VXO). This index soars when investors are fearful and sinks when they’re extremely complacent. It recently dipped to 9.32 — close to the lowest reading ever!

What These Developments Mean For Your Portfolio …

When I put them all together, these five developments tell me that we’re walking a tight rope right now. Naturally, you want to make hay when the sun shines. And right now, the “sun” of excess liquidity is shining on practically every asset out there — stocks, bonds, commercial real estate, you name it.

But this won’t last forever. It never does. There will come a time, possibly very soon, when risk explodes back onto the front pages. And when that happens, investors without a safety net are going to be in for a world of hurt.

And if you are going to put some money to work in riskier markets, I think you have to focus on select sectors and stocks where the fundamentals are the strongest.

That’s it for now. I’m off to hang even more Christmas lights, and spend some time with my two beautiful girls and my loving wife. Have a safe and wonderful Thanksgiving weekend!

Until next time,

Mike

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